January 21, 2014

The ACA: When Insurance Isn’t Insurance

We will be blunt. Hidden under the cloak of expanding health insurance, the Affordable Care Act (ACA) has fostered a massive subsidization of healthcare goods and services. These subsidies often have little or anything to do with what economists would consider the “insurance” part of health insurance – providing protection against financial catastrophe. Perhaps more troubling, if the past is prologue these subsidies will continue to grow, transferring huge amounts of money to politically favored groups and doing very little to decrease aggregate health spending – a presumed goal of health reform.

In order to understand these claims, it is necessary to take a step back and explain why insurance (of any form) is a good thing in the first place. Simply stated, insurance provides individuals with protection against unpredictable financial hardships not of their own making. Most of us don’t like risk, and therefore we are willing to pay other people to avoid uncertain outcomes. Therefore the benefits of insurance are to protect us from uncertain events. The key here is the uncertainty. If something is not going to cause financial distress, or the expense is relatively predictable, then, by definition, the service is not insurable. A health plan could cover the service, but that is a subsidy, i.e. other people in the insurance pool or an outside actor such as the government are simply paying for your service. It is not insurance.

Sadly, most of the discussion around what constitutes “real” health insurance under the ACA bears only a passing resemblance to the protection against financial risk that is the hallmark of insurance. For example, Secretary of Health and Human Services Kathleen Sebelius said: “Some of these folks have very high catastrophic plans that don’t pay for anything unless you get hit by a bus … They’re really mortgage protection, not health insurance.” What does Secretary Sebelius think insurance is? We don’t expect auto insurance to pay for our gasoline. Indeed, we buy auto insurance precisely so that we can meet our mortgage payments (or similar vital financial obligations) in the event that our car is stolen or worse. For a Cabinet Secretary to preside over the largest expansion of insurance since Medicare and not understand or care what insurance is supposed to be for…well, frankly we are shocked (and not in a Casablanca sort of way).

Secretary Sebelius mistakenly believes that a health plan isn’t an insurance plan unless it covers things such as routine annual visits to a physician or other services that we expect will occur each year and that we can budget for in advance. These types of services (while valuable and necessary) carry little to no associated financial risk and as a result, there is little insurance benefit to forcing the coverage of these services. It should be noted, though some may not like this fact, that this is also the case for many maternity services or for contraception. These have been two of the more controversial mandated services and they are effectively uninsurable in most cases. In fact, when maternity services are covered by insurance, the payments for these services are largely a subsidy with little risk sharing benefits. Perhaps the most apparent example of this is when an individual seeks to purchase insurance when they are already pregnant. While insurance companies were castigated for considering pregnancy to be a “pre-existing condition,” they were entirely correct in their assessment. If Secretary Sebelius wishes to state, as a matter of policy, that Americans should subsidize maternity care, then she should say so. Perhaps the majority of Americans will agree. But let’s not invoke the myth that this is some sort of insurance. Furthermore, there are probably better ways to subsidize this care then forcing its coverage into the premiums of everyone on the exchanges.

Even when our health insurance plans provide protection against financial risk, this protection comes at cost known as moral hazard. Full insurance, which drives the marginal cost of a service to zero, will cause folks to buy medical goods and services even if they don’t really need it. (Either patients will demand more of it or their providers will prescribe more of it, knowing that cost is not an issue.) This drives up health spending without a commensurate increase in benefits. Moral hazard may be inconsequential for services such as open heart surgery, but it can be quite large for other services, such as many prescription drugs, eyeglasses, contraception and even mental health care. And if the latter are not too costly, or are predictable, then coverage entails a subsidy with little or no insurance benefit making the coverage mandate even more problematic.

Insurers counteract moral hazard by requiring deductibles, copayments, and coinsurance. These measures balance risk spreading benefits and moral hazard. Low income individuals may feel the bite of financial uncertainty with relatively low medical spending. But most of these individuals will be enrolled in Medicaid and not in the exchanges. Most participants in the exchanges can plan for nontrivial annual deductibles and can bear the financial uncertainty associated with nontrivial cost sharing. Many of the lower tiered plans on the exchanges have relatively large amounts of cost-sharing – which makes them more like insurance than many products offered by employers. But actual catastrophic insurance plans are primarily available (likely for a political reason such as this long being a popular policy among the Republican opponents to the ACA) to individuals who are under 30 and these plans can’t be purchased using tax subsidies from the government.

Beyond limiting access to catastrophic plans, the ACA inhibits innovation in the design of health plans by setting a fairly rich set of minimum benefits for all insurance plans in the United States. This lack of innovation in plan design may be one of the largest and under discussed long term costs of the ACA. Perhaps more galling, Congress demonstrated their infinite wisdom by deciding to use the current employer-provided health system as a model for the future of health insurance. Under the ACA, the Secretary of HHS was tasked with determining a set of essential health benefits that were similar to a “typical employer.” Yes, the ACA has decided that the structure of benefits that has led to ever increasing health spending will be codified as the definition of insurance for every American.

The rule making process of determining the “typical employer” actually left Secretary of HHS with a good deal of latitude about what would be covered. There was an opportunity to move towards a mandate that each American have true insurance. But given Secretary Sebelius’ twisted definition of insurance, it shouldn’t be surprising that she ended up choosing a very generous package of services as the “minimum.” And coverage for some services known to be at risk for moral hazard, such as mental health and substance abuse coverage, must be covered with the same cost sharing as other services, which as we wrote about before has its own problems.

We believe that starting with generous existing employer plans as a basis for the services that should be covered is a fundamentally flawed strategy. Many features of these plans are more about quirks in the federal tax code than optimal insurance design. Employee health benefits are not taxed as income. Purchase eyeglasses on your own, and you use after tax dollars. Buy them through employer-sponsored insurance, and you use before tax dollars. Given these tax rules, it’s no surprise that employer provided health insurance evolved into pre-paid medical services plans. Of course, taxpayers pay for a good portion of these costs – a regressive subsidy that economists have long protested (in vain, of course.)

For a long time, individual insurance policies were far less generous than employer-sponsored policies. One likely reason is that these policies did not get the same tax deduction as employer-sponsored policies. As a result, many of these policies actually looked like true insurance. Lest sound economic thinking wear out its welcome, states have mandated minimum benefits standards for individual policies. (The mandates do not apply to the self-insured plans offered by the vast majority of large employers.) Today, the average state mandates 45 benefits, ranging from asthma management, alcoholism treatment, and treatment for HIV/AIDS to acupuncture, circumcisions, and mammograms.

A small percentage of these mandates are for services that economists would describe as insurable. Politics, not economics, explains the rest. A small number of providers and patients who pool resources to lobby for their cause prosper from these mandates. Taxpayers who are too diffuse to stand in opposition bear the costs. Congress will not be immune from this simple calculus and we expect the minimum benefit package to steadily grow. The ink was barely dry on the EHB rules from HHS before groups that were not included began their lobbying campaigns to demonstrate their importance. As this occurs, the ACA will be less and less about providing Americans with health insurance, and more and more about subsidizing favored interest groups.

The President has said that his second administration is all about creating jobs. What we didn’t realize that he must have been referring to creating lobbying jobs for healthcare interest groups.

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Many persons of Sec Sebilius’s age spent the first years of their working life covered by plans with little or no deductible. Right or wrong, that was certainly the common coverage in large businesses and some small ones throughout the 1960’s to the 1990’s. HMO’s built on this platform.

These plans were popular because there was no cost to the patient at the time of service. Medicine felt like a gift relationship– and it really was, in the sense of being a gift from the employer. (For those with Medicare and a good supplement, it felt even more like a gift.)

Many persons still feel like that is the “real health care.” High deductibles and paying up front feels like an insult.

This is why you will hear some describe the bronze plans of the ACA and similar policies as “junk insurance.” Even if strictly speaking it is “real insurance.”

The above is not a solution but an explanation. Arnold Kling had a good piece a few months ago, where he noted to John Cochrane that no nation in the world has built their health system on high deductible plans.